Chrysler LLC and the U.S. Treasury Dept. have formed a tentative agreement with banks and private equity firms holding $6.9 billion of the automaker’s debt. The entities have agreed to accept $2 billion and a small equity interest in the new company, paving the way for Chrysler to avoid bankruptcy and merge with the Italian automaker Fiat.

The agreement to reduce debt was confirmed by a Treasury official who said: “The agreement from Chrysler’s principal banks is an exceptional accomplishment in line with the President’s firm commitment that all stakeholders sacrifice to make this deal succeed.”

A deal with Fiat is now expected to proceed forward, with the Italian automaker owning 35% of Chrysler, while the United Auto Workers will own up to 55%, and the Federal government up to 10%.

The Chrysler deal with bond holders is significant, not only for Chrysler, but also for GM, since it could be a model for a deal at GM, whose restructuring to avoid bankruptcy is also dependent on debt holders taking an enormous “cram-down” on what they are owed.

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